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Long-standing regulation exempting private schools from sales and use tax held invalid

In a ruling that could have widespread impact, the Alabama Department of Revenue’s (“ADOR”) Chief Administrative Law Judge Bill Thompson held that private schools in Alabama are not exempt from state or local sales and use taxes and that a long-standing ADOR regulation to the contrary is invalid. Columbia Southern Education Group v. Baldwin County, Alabama, Admin. L. Div. (Aug. 15, 2013). The ADOR’s 1961 regulation was found to be invalid because it lacks statutory support, at least since 1977, and is “a wrongful usurpation of legislative authority by the Department.” The taxpayer has until September 14 to appeal the ruling to circuit court; it is not known whether it plans to do so.

The taxpayer, a private college, was audited by Baldwin County for unpaid county use tax for the period May 2003 through April 2009. The county determined that the taxpayer owed over $103,000 in use tax, penalties, and interest, although the county subsequently waived the penalties for reasonable cause. The taxpayer paid the tax and interest assessment in September 2009, but in March 2010, petitioned the county for a refund, which the county denied. Judge Thompson heard the case as special master and issued a final order invalidating the regulation at issue in May 2013. The taxpayer timely applied for rehearing, raising new defenses and new facts.

By way of background, Alabama enacted its sales tax in 1959. The statute was amended later in the same legislative session, by separate act, to include an exemption for sales of tangible personal property to private schools and for school lunches. The ADOR promulgated the regulation at issue, Rule 810-6-3-.47.02, in March 1961. The sales tax exemption statute was amended again in 1963 to add an unrelated exemption. The private school exemption act was excluded from the statute under the 1963 amendment. The ALJ concluded that the exemption was therefore repealed.

On rehearing, the taxpayer argued that the 1963 act did not repeal the exemption because (1) the 1963 act did not expressly state that it was repealing the exemption, (2) the Alabama Legislature simply forgot that the previous version of the sales and use tax statute had been amended by separate act to provide an exemption for private schools, and (3) by amending its regulation subsequent to the supposed repeal of the private school exemption, the ADOR must have concluded that the exemption remained valid.

Judge Thompson rejected the taxpayer’s third argument first, presuming “that the Department administrators were simply unaware that the exemption was no longer in the law, and thus incorrectly assumed when they subsequently amended [the regulation] that the exemption was still applicable.” Judge Thompson agreed with Baldwin County that the ADOR’s actions, at best, “indicate[] inattentiveness . . . to the tax laws of the state, or at worst, a willful failure to follow existing law by substituting [its] judgment . . . for that of the legislature.”

Turning to the taxpayer’s first and second arguments, Judge Thompson agreed with the taxpayer that it is not entirely clear why the private school exemption was not incorporated into the statute in 1963. Regardless of the reason (if any) for its removal, however, the ALJ found that the exemption was indeed repealed—pointing out that the sales and use tax statute has been reenacted in its entirety on numerous occasions since 1963, without any reference to the private school exemption. However, Judge Thompson ruled that, even if subsequent reenactments of the sales and use tax code without reference to the special 1959 act did not effectively repeal the exemption, the Alabama Legislature conclusively settled the issue when it adopted the recodified version of the Alabama Code in 1977.

The 1977 act that adopted the Alabama Code of 1975 contains a repealing provision stating that “[a]ll statutes of a general and permanent nature not included in the CODE OF ALABAMA 1975 are repealed on the date on which such Code becomes operative and effective.” Further, the Alabama Code of 1975 contains Section 1-1-10, which provides that “all statutes of a public, general, or permanent nature, not included in this Code, are repealed.” Judge Thompson stated that “even if the private school exemption was not repealed by being omitted from the exemptions statute . . . in 1963, and also the later amended versions of the statute, it clearly was repealed by being omitted from the recodified Code of Alabama 1975 in 1977.”

Interestingly, this case is not the first time Judge Thompson has ruled that the private school exemption regulation is invalid. In 1989, in Ala. Dep’t of Revenue v. Roberts Cafeteria, Inc., Admin. L. Div. Dkt. No. S. 87-179 (Jan. 1, 1989), he held that the private school regulation was invalid as applied to state sales tax. The holding in that case was cited with approval in 2000 in Ward International Trucks, Inc. v. Ala. Dep’t of Revenue, Admin. L. Div. Dkt. No. S. 00-216. Neither case was appealed by the ADOR, yet without public explanation, the agency chose not to repeal the regulation invalidated by its own Administrative Law Division.

While it is true that local taxing jurisdictions are required by statute to follow all properly-issued ADOR sales and use tax regulations, Judge Thompson stated that localities are “not required to follow a patently invalid regulation that is contrary to Alabama law, as is the private school exemption regulation.” Going further, he stated that “[t]he holding in this case is based on a simple premise. The Revenue Department cannot create an exemption from tax through its rule-making authority. . . . [And] if the substance of a regulation is unsupported by a statute, then the regulation must be rejected, no matter how long the regulation has been in existence.”

Judge Thompson concluded his opinion by reiterating that the passage of time does not somehow validate an otherwise invalid regulation. It is unclear what course of action the ADOR will now take, but the authors predict that legislation ratifying the questioned regulation will be introduced next Spring due to the negative impact on approximately 500 private schools and colleges in Alabama if the ruling is not overturned on appeal or the ADOR commences a rule-making proceeding to repeal the regulation.